Budget deal leaves U.S. defence sector in limbo

WASHINGTON (Reuters) - Pentagon officials and weapons makers on Wednesday expressed relief after Congress approved a two-month delay in huge budget cuts, but warned that a longer-term fiscal solution is urgently needed to lift the uncertainty hanging over the sector.

"Congress has prevented the worst possible outcome by delaying sequestration for two months. Unfortunately, the cloud of sequestration remains," Defence Secretary Leon Panetta said in a statement. "Congress cannot continue to just kick the can down the road."

Votes by Congress on New Year's Day delayed automatic budget cuts known as "sequestration" until March 27, when lawmakers must vote to increase the U.S. debt ceiling.

The 157-page deal reached on Tuesday to avert the "fiscal cliff" delayed $109 billion in U.S. spending cuts - including $54.7 billion due to come out of military spending, but left many larger issues unresolved.

Defence shares were lifted by a rally in the overall market as investors breathed a sigh of relief about the last-minute deal, but some companies' shares lagged the broad market due to continued uncertainty about future military spending.

"Merely delaying sequestration by a couple of months will do little to resolve the uncertainty and chaos surrounding the defence budget," said Todd Harrison, an analyst at the private Center for Strategic and Budgetary Assessments.

Lockheed Martin Corp, the Pentagon's biggest supplier, said it hoped the agreement would help eliminate the need for automatic across-the-board cuts it said would harm government programs and national security.

Until then, "there will be an overhang on our industry that stifles investment in plant, equipment, people, and future research and development essential to the future health of our industry," said Jennifer Whitlow, spokeswoman for the maker of F-35 fighter jets and Aegis missile defence systems.

"If sequestration is not solved in the next 57 days, it would be an abdication of responsibility by the leaders of this country, one that will only heighten Americans' cynicism and cement the public image of a gridlocked Washington that simply doesn't work," said the group's president, Marion Blakey.

Lockheed and other big arms manufacturers including Boeing Co and Northrop Grumman Corp have complained about the difficulty of running their businesses while facing the potential indiscriminate, automatic spending cuts.

The U.S. unit of Britain's BAE Systems said the uncertainty had "made it virtually impossible to plan near and long-term business decisions" and urged Congress to find a balanced, long-term solution before the March deadline.

The cuts are setting up to be even more painful if lawmakers don't agree on an alternative by March 27, since they would have to be squeezed into a shorter period.

President Barack Obama has excluded uniformed military personnel from being hit by the spending cuts, but some of the department's 800,000 civilians could face up to four weeks of furloughs, or unpaid leave.

If the Pentagon must implement cuts after the March deadline, hundreds of thousands of employees may be forced to take up to a month of leave within just four months, which could create significant disruption of Defence Department operations.

Pentagon spokesman George Little could not specify how many civilians might be furloughed if the cuts were implemented, but he declined to rule out the possibility that virtually all 800,000 might have to take at least some unpaid leave.

"This is not an abstract concept. This is something that will have an impact on real people, doing real work on real missions for this department," Little said.

Loren Thompson, a Virginia-based defence consultant, said the news was not all bad.

He said the last-minute agreement by lawmakers signalled that sequestration cuts were unlikely to ever be implemented as currently planned, although some additional cuts were likely.

"When the chips are down, the two parties can find common ground and that means sequestration is not going to happen the way it is currently mandated," Thompson said. "This is not just a reprieve for the defence industry, it's a signal that the worst aspects of sequestration are never going to occur."

Byron Callan, analyst with Capital Alpha Partners, said an eventual compromise was likely to include some further cuts to defence spending, in addition to $487 billion in cuts already due to be implemented over the next decade.

"Defence spending absolutely will be part of the next debt ceiling/sequestration cliff debates," Callan wrote in a note to investors.